The rational expectations hypothesis was first formulated in 1961 by
John F. Muth to explain how traditional models of Keynesian economics
fail to predict prices in speculative markets. One such Keynesian model,
the Phillips curve, proposes that a government can lower the rate of
unemployment by stimulating inflation and thereby encouraging companies,
which anticipate higher revenues, to raise wages and attract more workers.
Lucas' critique of the Phillips curve shows that inflation may continue
to rise in the long run without a corresponding drop in unemployment
because higher production costs and higher consumer prices can eventually
offset higher revenues and higher wages, thereby dampening the expectations
of both companies and workers. Lucas was also known for his contributions
to investment theory, international finance, and economic growth theory.
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